FUNDS, FEES & AFFILIATES (OH MY!) SEC OCIE’s Examination of the Private Fund World Moderators: James W. Van Horn, Jr., Hirschler Fleischer, PC Marc R. Lieberman, Kutak Rock LLP Presenters: Matthew D. Harris, Securities Exchange Commission, Chicago Office Edward Schwartz, ORG Portfolio Management NAPPA SEC Working Group Panel 2015 NAPPA Legal Education Conference June 25, 2015 AGENDA I. Overview Marc Lieberman II. OCIE Examinations Matthew Harris A. Examination Process B. Exam Priorities C. Examination Results III. Panel Discussion Jim Van Horn Marc Lieberman A. Fee Allocations, Disclosure & Transparency Matt Harris B. Fiduciary Duty of Private Fund Advisers Ed Schwartz C. Role of Fund Administrators & Auditors D. Independent Monitors IV. Questions F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 2 OVERVIEW Increased Federal Oversight of Private Investment Funds 2010 – Dodd-Frank Act amends Investment Advisers Act of 1940 (Advisers Act) - Private Fund Advisers (PFAs) must register with SEC June 2011 – SEC Adopts Rules - PFAs ≥ $150 mm to register Oct. 9, 2012 – OCIE Letter to PFAs announcing “Presence Exams” May 2, 2012 – OCIE Director di Florio Speech – PFA Compliance with Advisers Act F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 3 OVERVIEW Increased Federal Oversight of Private Investment Funds May 11, 2012 – OCIE Director Champ Speech - “What SEC Registration Means for Hedge Fund Advisers” January 9, 2014 – OCIE /NEP Examination Priorities for 2014 (PFAs prioritized) January 28, 2014 – OCIE “Risk Alert” re: investor due diligence of PFAs May 6, 2014 – OCIE Director Bowden, “Spreading Sunshine in Private Equity” January 13, 2015 – OCIE/NEP Examination Priorities for 2015 (PFAs prioritized) F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 4 OVERVIEW SEC Divisions and Working Groups Focused on PFAs Division of Investment Management Division of Enforcement: Asset Management Unit OCIE: Private Fund Specialized Working Group F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 5 OCIE EXAMINATIONS 2015 PFAs subject to the Advisers Act and adopted SEC Rules All PFAs must have the following: Written compliance policies & procedures and a CCO Current, complete, accurate and true books and records Code of ethics establishing standards of conduct for staff No false or misleading advertising or advertising that contains untrue statements of material fact Custody Rule compliant procedures F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 6 OCIE EXAMINATIONS 2015 RIAs are fiduciaries under the Advisers Act Obligation to act in the best interests of their clients and provide investment advice in their client’s best interest Owe a duty of loyalty and good faith F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 7 OCIE FOCUS FOR 2015 Practices/Products presenting heightened risk to investors (e.g., alternative investments) Investigative Targets Conflicts of Interest Deceptive Marketing F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 8 CONFLICTS OF INTEREST F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 9 CONFLICTS OF INTEREST Particular focus on: Undisclosed/unfair compensation arrangements Hidden fees and compensation Failure to apply fee offsets correctly “Market” expenses far greater than market Undisclosed affiliations F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 10 CONFLICTS OF INTEREST Particular focus on: Misallocation of investment opportunities Favoring insiders/high commitment investors Favoring predecessor/successor funds/investors F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 11 CAMELOT ACQUISITIONS Private Equity Firm Founder Takes Plea Deal in $9.3M Theft Case The founder of a New York private equity firm took a plea deal for stealing $9.3 million from investors and spending it on jewelry, a luxury car and rent. West Point grad Lawrence Penn III copped to grand larceny and falsifying business records in exchange for 2 to 6 years in prison. He must also make restitution of $8.3 million and relinquish his company’s interest in the fund. F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 12 CAMELOT ACQUISITIONS Private Equity Firm Founder Takes Plea Deal in $9.3M Theft Case Penn allegedly siphoned cash from Camelot Acquisitions to shell a company set up by his pal Michael Ewers – who also pleaded guilty for his role in the scheme that ran from 2010 to 2013. The diverted cash was made to look like payments for Ewer’s services but actually served as a front, prosecutors said. F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 13 DECEPTIVE MARKETING BlackRock to Pay $12 Million Penalty for Failing to Disclose Conflict of Interest BlackRock agreed to pay the SEC $12 million to settle allegations that it failed to inform clients about a conflict between a fund manager’s private holdings and portfolios he supervised for BlackRock clients. F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 14 DECEPTIVE MARKETING F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 15 DECEPTIVE MARKETING F-Squared Prosecution Fund advertised a successful 7-year track record with strategy that didn’t exist during the specified period. F-Squared agreed to retain an independent “compliance consultant” [plus pay $35 mm] Take Away: Laser focus on “facts” alleged in marketing materials, including Asset Valuations and Returns F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 16 VALUATION Heightened investigation of valuation procedures and techniques Targets Hypothetical returns False performance figures False assurances about how value is ascertained Improper valuation techniques Use of friendly “broker marks” F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 17 MISCELLANEOUS CONCERNS Focus on funds deviating from investment guidelines or pursuing undisclosed strategies F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 18 MISCELLANEOUS CONCERNS Accuracy of fund distributions F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 19 MISCELLANEOUS CONCERNS Accuracy of fund governance F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 20 TRENDS Increased use of Independent Compliance Monitors or Fee Monitors Should we demand them? F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 21 TRENDS Increased Disclosures/Compliance Procedures Theoretically, heightened SEC scrutiny should lead to a decrease in fraud, but will it? F UNDS, FEES & AFFILIATES (OH M Y!) J UNE 25, 2015 22 NAPPA SEC Working Group Marc R. Lieberman [email protected] James Van Horn, Jr. [email protected] Peter Borkon [email protected] Jake McMahon [email protected] Ryan S. Stippich [email protected] Examination Priorities for 20141 January 9, 2014 I. Introduction The National Examination Program (“NEP”) is publishing its 2014 examination priorities to communicate with investors and registrants about areas that the staff perceives to have heightened risk and to support the Securities and Exchange Commission (“SEC”) mission to protect investors; to maintain fair, orderly, and efficient markets; and to facilitate capital formation. These examination priorities areas were selected collaboratively by senior staff from the NEP’s twelve offices, as well as by senior representatives of other SEC divisions and offices, based upon an assessment of a variety of information, including: • Information reported by registrants in required filings with the SEC, • Information gathered through examinations conducted by the NEP and other regulators, • Communications with other U.S. and international regulators and agencies, • Comments and tips received directly from investors and registrants, • Data maintained in third party databases, • Interactions with registrants, industry groups, and service providers outside of examinations, and • Industry and media publications. The NEP’s examination priorities address issues that span the entire market, as well as issues that relate specifically to particular business models and organizations. The market-wide priorities are addressed first, followed by the priorities for each of the NEP’s four program areas: (i) investment advisers and investment companies(“IA-IC”), (ii) broker-dealers (“B-D”), (iii) exchanges and self-regulatory organizations (“SROs”, and collectively, “market oversight”), and (iv) clearing and transfer agents (“CA” and “TA”). This description of NEP priorities is not exhaustive. While the NEP expects to allocate significant resources throughout 2014 to the examination of the issues described below, the NEP will conduct additional examinations in 2014 focused on risks, issues, and policy matters that are not discussed here. These additional examinations may result from market developments, new information learned from 1 The views expressed herein are those of the staff of the Office of Compliance Inspections and Examinations, in coordination with other SEC staff including the Divisions of Trading and Markets, Enforcement, and Investment Management. The Commission has expressed no view on its contents. This document was prepared by the SEC staff and is not legal advice. 1 examinations or other sources, and coordination with other regulators. Similarly, the NEP may focus its resources on a subset of the risks and issues identified here. II. NEP-Wide Initiatives The most significant initiatives across the entire NEP include: Fraud Detection and Prevention. Our Nation’s capital markets are built on trust. Scams, theft, unfair advantage, and other fraudulent conduct erode that trust and adversely affect investors and the efficient functioning of our markets.